Conference on Financial Crisis: The Good, The Bad, And The Ugly

Published on April 10, 2009

The good news regarding the current financial crisis is that the U.S. is not repeating the same primary mistakes that turned a short-lived financial crisis into the long-lived Great Depression, said John Cochrane, Myron S. Scholes Professor of Finance. “Therefore, we still have the potential to emerge from this rather quickly,” Cochrane said during a panel at the University of Chicago Conference on the Financial Crisis.

The conference, organized by the Money and Markets Workshop of the Council on Advanced Studies in Humanities and the Social Sciences, featured four panels of social science experts from London and throughout the United States. The day-long event was held at the Franke Institute for the Humanities at the Joseph Regenstein Library at the Hyde Park campus on April 10.

In contrast with the Depression, in this crisis the Federal Reserve has purchased Treasury bills to allow people to hold more money and less of other assets, he said. Acting as lender of last resort, the Fed has prevented cash runs creating chaotic bank failures, Cochrane said. Furthermore, deregulation allows for bank takeovers, instead of closures, he said.

“The third thing we’re doing right so far is that we are avoiding direct regulation, or fighting deflation with price supports and cartelization of industries,” Cochrane said.

The bad news is that the United States is turning into “Bailout Nation” by refusing to let any large company, especially any large financial company, fail, he said. “Like a horror movie, TARP, the plan to buy troubled assets or inject equity, refuses to die and keeps coming back in different forms,” Cochrane said. “It’s now standing in the way of recovery, rather than helping.”

Secondly, the current fiscal stimulus package will not raise the overall level of the economy, he said. “If I borrow from A and give to B, B has some money to spend, is very happy, and will vote for me next time around,” Cochrane said. “But A was going to do something with that money, now doesn’t have that money, and isn’t going to spend it. The overall level of spending cannot go up from this. Typically, that money was going to be lent, which is the last money you want to take in a credit crisis.”

The danger of the stimulus package is inflation, he said. “The crisis will end and people will get tired of holding trillions of dollars in cash,” Cochrane said. “At the moment, the Fed must sell a lot of Treasury bills and raise interest rates. Will the Fed be willing to raise interest rates? We will still be in a recession, many people will be unemployed and hurting, and it will be very difficult politically to raise interest rates.”

A more dangerous scenario will occur if the Fed is unable to take back the excess money, he said. In addition to incurring massive deficits with the possibility of low growth and high taxes, the U.S. government has tens of trillions of dollars in credit guarantees, Cochrane said.

“To soak up money, the Federal Reserve has to sell Treasuries and bring in money,” he said. “What if it tries to do that at the same time everybody else is trying to sell Treasuries? It simply can’t do it. We’re not going to raise $2 trillion in taxes to soak up that money. The answer is Argentinean-style inflation, not just late-1970s, U.S.-style inflation.”

                                                                                                                — Phil Rockrohr